Target (NYSE:TGT) is finally selling off its credit card portfolio to Toronto-Dominion (TD) Bank for $5.9 billion after a long search for potential buyers. [1] The recently announced deal is likely to close by the first half of 2013. [2] Both of the companies will play a vital role in this business thereafter with Target taking care of operations and customer service and TD responsible for risk and funding of the portfolio. [2]

This deal will allow Target to focus on its retail business and Canadian expansion plans. Moreover, it will lead to a significant reduction in retailer’s long term debt. With the upcoming Canadian expansion, Target will be in a better position to further reduce its debt. [3]

Most of the retailers outsource their credit card due to the risks associated with this business. Managing a credit card business can be difficult, and thus outsourcing can ensure smooth operations and enable the retailers to focus on their primary businesses. Target kept this operation in-house since 1995 with its Target National Bank. [4] In 2010, the retailer limited the usage of the credit card to its stores in order to reduce the risks. [4] Target has now decided to sell off its credit card portfolio to reduce debt.

The Sale Will Result In Lower Debt

Target will get $5.9 billion in cash with the sale of its credit card portfolio. The seven year agreement between the two companies states that Target Visa and private label customer credit cards will be exclusively issued by TD in the U.S. [2] The bank will pay an amount equal to the retailer’s outstanding receivables at the time of deal closing. [2] The transaction is expected to reduce Target’s long term debt, which will be a positive factor for the growth.

Toronto-Dominion is the sixth largest bank in North America and this deal provides Target with a strong partner for its credit card operations which accounts for 2% of its revenues. [5] Target’s customers will continue to enjoy the benefits of shopping with these cards such as 5% off on purchases and free online shipping. [2]

The profits will be shared between the two companies, and for Target, the lower profits will be more than compensated by the increase in the cash pool. The Credit Card division constitutes only 4% of the company’s value according to our estimates, making it a business worth less than $2 billion for Target. Assuming that most of the profits will be shared by TD, and increasing Target’s cash balance by $5.9 billion in our pricing model, we conclude that Target’s stock could see potential upside of 10%.

Canadian Operations Can Further Assist In Debt Reduction

Target is scheduled to open its first store in Canada in April 2013 and plans to end the year with 135 stores. [3] This will mark the beginning of the retailer’s international expansion. The international business contributes only about 7% to the company’s value based on our expectations for future expansion, and might not be a valuable driver for the stock. However, once the Canadian operations start generating healthy revenues, the retailer will be in a better position to further pay off its debt.

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